4th Quarter, 2017

Eyes Bigger than Your Stomach!: As my mother used to say, over and over, this sentiment pretty much sums up Americans’ insatiable appetite for consuming. More is Better! Quantity v. Quality! Right?! Based on a recent 2017 International Council of Shopping Centers summary of retail consumption, total retail sales (excluding restaurants, gasoline and automobiles) is estimated at $3.4 trillion nationwide, with 11%, or $400 billion represented by on-line sales, 31% from Amazon alone. Contrary to popular belief, E-commerce isn’t the lean and mean culprit behind declining bricks & mortar sales, but our own beloved commercial real estate industry. A fundamental problem today with retail in the US is massive over capacity. ICSC estimates that the U.S. has about 1 billion square feet of retail space more than it needs. Currently there is close to 25 square feet of retail space per capita (roughly 50 square feet, if small shopping centers and independent retailers are added). In contrast, Europe has about 2.5 square feet per capita.

“Don’t let the same dog bite you twice”: Another fundamental of the “overstored” issue is the mismatch between retail trends and the construction cycle. Trends change much faster than permits can be issued, buildings constructed and leased. That lag can be consequential and painful. Look at the growth in big malls since the 1990s. Forbes notes that “since 1995, the number of shopping centers in the U.S. has grown by more than 23 percent and the total gross leasable area by almost 30 percent, while the population has grown by less than 14 percent.” All of the retail construction reflected a very ’90s shopping perspective, one that’s considerably different today. As you can assume, the failure of retail is more than just the rise of the internet: shopping as therapy and conspicuous consumption offer less satisfaction today than they once did. As much as we look to the Millennials and the other younger generations as the torch bearers of pop culture and consumption, with their demand for authenticity and value, consumers across generations are embracing experiences over simple purchases, vastly different from grandmas “downer” visit to the local power center. The commercial real estate landscape is littered with millions of square feet of dying retail; think Sears, Macy’s, JC Penny, Ross, etc... All of these “anchors” and others will be collectively shuttering 1000’s of stores over the next year. Default “blame” always goes to Amazon. There’s little doubt that the fifth-largest U.S. company by market cap has been disrupting traditional retailers, but that is only part of America’s retail dump. Fundamentally, America is suffering from indigestion caused by unimaginative merchandising concepts, ancient history, hubris, cheap debt, over capacity as referenced earlier, and a massive failure to adapt to rapidly changing consumer tastes. This lag has been readily apparent for more than a decade. Now the industry is paying the price. But, please, don’t lose perspective, with the clear understanding that the vast majority of retail is alive and well, thriving and relevant for 3.4 trillion reasons. Hold the Ex-Lax!

The Grass Isn’t always Greener: According to Newmark Realty Capital’s “2017 Bay Area Economic” summary, the 7.6 million people in the 9-county Bay Area represent 19.2% of the State’s population and 2.3% of the Nation’s. Compared to national economies, the Bay Area’s 2016 $781 billion GDP would rank 18th in the world, between Turkey and the Netherlands. If it were a state, the Bay Area would be ranked fifth between Florida and Illinois. At $105,482 San Jose had the highest GDP per capita in 2016 among major US SMSA’s. Bay Area GDP growth is running at over twice the national average: at 5.4% in 2016 for San Francisco/Oakland and 5.9% for Santa Clara County. The Bay Area has more Fortune 500 companies (36 with combined sales of $1.3 trillion) than any U.S. region except New York City (with 46), 68% of California’s total. The list of Fortune 500 companies is growing, fed by a herd of “Unicorns”. As of September 2017, of the 216 start-ups worldwide with a $1billion valuation, 56 were from the Bay Area, versus 52 from the balance of the USA.

Yet, the Bay Area is not supporting this economic growth with housing or transportation infrastructure. Since 2011, 531,000 new jobs were created and only 124,000 new housing units. The number of commute miles spent at speeds below 35 MPH grew 80% between 2010 and 2016. Bay Area’s traffic is now second worst in the Nation, behind LA. Without adequate investment in housing and infrastructure, the Bay Area’s economic growth is severely constrained. What to do?

Back to the Future: In 1992, I launched DJM Capital Partners in San Jose with a focus on acquiring well located multi-family properties primarily in the Bay Area from defunct Savings & Loans. We succeeded in sourcing acquisitions and realizing alpha returns on investment over a period of 5 years. Some of you may remember this success nearly 30 years ago. Silicon Valley is a very different place today than in the early 90’s, represented by some of the highest capitalized value companies in the world like Apple, Google, Intel, IBM, Facebook, HP, Oracle, Cisco to name a few. Technology is the engine that drives global innovation and local employment in Silicon Valley. Artificial Intelligence, driverless cars, robotics, the Internet of Things (IOT) is the next revolutionary breakthrough on the horizon for Silicon Valley, as well as startup hubs in NYC, Silicon Beach, Austin and Provo. Since 2003, DJM’s focus has been on the acquisition of multi-tenant retail properties in coastal California. As of the end of 2017, we have generated returns in excess of 22% IRR per year over that period of time. I would put DJM’s returns against many of the “seeking alpha” technology hedge funds in my back yard. Since 2015, DJM launched its first single tenant net lease retail fund-it’s “Bar Bell” investment strategy. That investment has consistently delivered current cash flow/returns in the mid-8% range, with 29 uninterrupted monthly dividends. In 2018, DJM will venture back into multi-family investments in Silicon Valley. We are currently negotiating a joint venture with a highly respected local developer to build over 600 units over the next three years. This investment opportunity will be presented to our partners over the next couple of quarters on an individual basis. DJM Net Lease Retail Fund II is also well into the institutional fund raise. Both the local multi-residential development opportunity and Fund II will be made available for private equity investments later this year. In light of the changing landscape in multi-tenant retail as referenced earlier, we intend to liquidate several of our shopping centers that we believe have reached maximum value. We estimate that these properties represent nearly $60 million of profit, notwithstanding that 100% of original equity, plus profit that was distributed to those investors in December 2012. All good!! All of us at DJM are excited over the prospects of generating solid, defensible returns to our investors and diversifying and growing in 2018. Happy New Year!